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Course 404
Style-Box-Specific versus Flexible Funds


Legendary fund manager and former head of Fidelity Magellan Peter Lynch was an opportunist. Sometimes he liked growth stocks. Other times, value investments held more allure. Large companies struck his fancy but so did smaller firms. Funds that are managed in this fashion often don't stick to one part of the Morningstar style box (see lesson 207), but migrate from box to box.

Some investors prefer this sort of flexibility, with a manager who is free to mine opportunities (and avoid trouble spots) wherever they may crop up. Other investors, meanwhile, prefer for their funds to stick to one style, so they can more easily build and maintain diversified portfolios according to their needs.

Morningstar may seem to be among the "style purists." After all, we categorize funds by narrow investment styles, such as large growth or small value. But we don't necessarily favor funds that stay in the same part of our style box year in and year out. In fact, while we know that style-specific funds have their charms, we acknowledge that flexible funds also have advantages. Neither one is better than the other. It's up to you to decide how to use each in your portfolio.

Flexibility's Power, Purity's Charms

Lynch wasn't the only fund-industry luminary who would have the freedom to pursue his best ideas, wherever they may lie. David Decker of Janus Contrarian JSVAX, scours a much broader opportunity set than most of his large-blend peers and is willing to pick up stocks whose value has not yet been realized by the majority of the market. Over the last several years, the fund has traveled from the large-blend to the large-growth to the mid-value squares of the style box.

But flexible funds have their downside: They can make building a portfolio tricky. After all, if a fund is a small-cap fund one day and has large-company tendencies the next, how can investors be sure they're really diversified? No wonder some advisors and investors are wary of flexible funds.

Style-specific funds, meanwhile, tend to cleave to one part of our style box. They always invest in, say, small-value stocks or mid-cap growth stocks. Using index funds, such as Vanguard Value VIVAX, is one of the more certain ways to ensure style purity in a fund. As you can imagine, it's much easier to build and monitor a portfolio of style-pure funds. If you select four style-pure funds that invest in different ways, you can be confident that they'll continue to invest that way. Thus, you're always sure that you're diversified.

Using Flexible Funds

Writing off flexible funds altogether can mean tossing aside some great funds and fund managers, however. Here's how even style-specific devotees might work flexible funds into a portfolio.

Give away some but not all control.

Use style-specific funds at the core of your portfolio. Treat them as building blocks to meet your asset-allocation goals and save a portion of assets for flexible funds. That way, your overall asset allocation won't get beyond your control.

Because change is a given, monitor flexible funds carefully.

Keep an eye on where and why your flexible fund's manager is moving. And if you choose to devote significant assets to more than one flexible fund, enter your portfolio in's Instant X-Ray to take note of how your overall portfolio is positioned. Instant X-Ray will tell you how much you have in each investment style. If all of your flexible-fund managers are favoring large-growth stocks, you may want to assume they know something you don't and let them ride. Or you may want to temper that bet somewhat. In any event, know what you own.

Quiz 404
There is only one correct answer to each question.

1 Managers who run flexible funds:
a. Stick to one area of the Morningstar style box.
b. Invest in securities of various sizes and styles.
c. Usually work at T. Rowe Price.
2 Flexible-fund managers:
a. Return more than style-box purists.
b. Return less than style-box purists.
c. May return more or less than style-box purists.
3 It is easiest to build and maintain:
a. An all flexible-fund portfolio.
b. An all style-box-specific-fund portfolio.
c. A mix of both.
4 If you choose to use flexible funds in your portfolio, which of the following is not a good idea?
a. Using them as core holdings and not monitoring them.
b. Monitoring them closely.
c. Using them outside your core.
5 If two of your flexible-fund managers are both favoring the same type of stocks at some point in time:
a. You should sell one of the funds to eliminate overlap.
b. You should leave the funds as is--the fund managers know something that you don't.
c. You need to decide whether you're comfortable with the imbalance.
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